To the annoyance of some shareholders, Proact IT Group (STO:PACT) shares are down a considerable 35% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 55% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Proact IT Group’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 10.95 that sentiment around Proact IT Group isn’t particularly high. We can see in the image below that the average P/E (15.2) for companies in the it industry is higher than Proact IT Group’s P/E.
Proact IT Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Proact IT Group, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Proact IT Group saw earnings per share decrease by 37% last year. But it has grown its earnings per share by 7.3% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 5.3% annually. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Proact IT Group’s Balance Sheet
Proact IT Group has net debt worth 24% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Proact IT Group’s P/E Ratio
Proact IT Group’s P/E is 10.9 which is below average (14.4) in the SE market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. What can be absolutely certain is that the market has become significantly less optimistic about Proact IT Group over the last month, with the P/E ratio falling from 16.9 back then to 10.9 today. For those who don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Proact IT Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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